Banks Could Face U.S. Home-Equity ‘Payment Shock,’ Moody’s Says

By Erika Waddell -
Jun 25, 2013

Home-equity lenders could see
delinquencies rise in the next two years as borrowers face a
“payment shock,” Moody’s Investors Service said.

The majority of home-equity loans were issued during the
housing bubble before the 2008 financial crisis when
underwriting standards were “dismal,” Moody’s said today in a
report. Those loans will reach the 10-year mark between 2015 and
2017, when borrowers who are paying only interest must start
repaying principal, and some won’t be able to keep up, Moody’s
said.

Home-equity loans were among the largest sources of bad
debt in the Federal Reserve’s stress tests of U.S. banks
conducted earlier this year, with $37.2 billion of projected
losses on junior-lien and home-equity loans. Those tests were
designed to show how the biggest U.S. financial firms would fare
in a severe economic shock.

“This will slow down the improvement in the banks’ non-performing levels,’’ Sean Jones, associate managing director of
banking at Moody’s, said in a telephone interview. “It’s
another indicator that they will remain stubbornly high even
though the economy elsewhere is slowly recovering.”

Of the 15 rated U.S. regional banks with the largest
holdings of home-equity loans, 12 had portfolios greater than
their tangible common equity as of March 31, according to the
report. The four biggest lenders have comparatively smaller
concentrations, according to Moody’s, which said it doesn’t yet
know what the costs will be to banks.

Moody’s sketched a scenario in which a homeowner with a
$210,000 first-lien mortgage and $40,000 drawn from a home-equity line could face a 26 percent increase in monthly payments
when the home-equity loan reaches the 10-year mark.

Banks should start preparing for the payment shock now by
surveying clients likely to default and making modifications to
reduce losses, according to the report. A stronger housing
market and higher capital levels at banks should help mitigate
the risk, Moody’s said.